How will Trump’s sweeping tax reform bill impact Mexico?

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The US Senate voted 51 to 49 to pass an historic tax reform bill on December 2 that is expected to impact Mexico from both a tax and economic perspective.

As a key initiative for President Trump’s
administration, the proposed tax reform is generally aimed at
addressing, among others, three main issues: (i) making the
Internal Revenue Code simpler; (ii) lowering both
individuals’ and businesses’ income
tax rates; and (iii) implementing international tax rules to
repatriate offshore investments.

Although generally similar to the Tax Cuts and Jobs Act
originally approved by the House of Representatives on November
16, the amended tax reform bill approved by the Senate somehow
diverges on different important issues that are still to be
discussed by Congress, but it is at least consistent in
addressing these three issues that will most certainly become
law at some point early next year. If passed, it will represent
the most significant reform that the Internal Revenue Code
would have suffered since Regan’s 1986 Tax Reform
Act.

To name a few of the most relevant changes related to
business taxes, the reform includes proposals to:

Permanently reduce the corporate income tax rate from 35%
to 20%;

Impose a minimum tax on deductible payments made to
foreign related entities. Originally, a 20% excise tax was
proposed to be applied to payments made to foreign
subsidiaries, but this is still an item open for discussion
by Congress;

Implement a mandatory "toll tax" on previously untaxed
foreign earnings. A 14.49% tax rate is proposed on previously
untaxed foreign cash and cash equivalents, with a reduced
7.49% tax rate for illiquid assets, allowing for payment of
the tax liability over a period of eight years;

Implement a territorial tax system by providing for a
100% dividend received deduction on certain foreign-source
dividends received by US corporations;

Limit business interest deductions in certain cases;

Encourage transfers of intangible property from CFCs to
US parent companies;

Allow businesses to immediately write off the costs of
new equipment during the next five years, instead of depreciating the value of assets
over time, ending after five years.

Out of these specific changes, the permanent reduction of
the corporate income tax rate from 35% to 20% has caught most
of the international forum’s attention since such
a drastic alteration could directly and indirectly impact
economies that rely upon multinationals’ setting
up shop in their jurisdictions driven by their own version of a
tax friendly environment, as well as on investments from
private equity firms that will have more incentives to invest
their money in the US.

In Mexico, the corporate income tax rate is currently 30%
– by no means the most competitive all around
– but if compared to the 35% rate applicable to
American businesses, it could prove to be somehow appealing.
However, once the American corporate income tax rate is
effectively reduced, saving up to a third in taxes will most
certainly sound like a good enough driver to force many
multinationals into migrating across the border. Of course
other circumstances should also be weighted-in prior to
migrating companies out of Mexico into the US, the most
relevant of which are, for instance, that Mexican labour costs
are still significantly lower than those in the US and that the
maquiladora regime requires paying marginal taxes for
manufacturing operations in Mexico. Nevertheless, our view is
that Mexico will have to adjust accordingly in order to avoid
investment leakages.

Likewise, from a Mexican perspective, the reach of the
reform’s enactment in that a 20% excise tax could
be applicable to payments made to foreign related parties would
also spread across multinationals that currently rely upon
supply chain structures designed to manufacture products in
Mexico, benefiting from the maquiladora regime. The
maquiladora regime has been traditionally used by
multinationals seeking for cheap manufacturing costs under
advantageous tax environments (i.e. permanent establishment and
import VAT exemptions), which also allow them to export
products back into the markets in which the goods are finally
retailed.

It would also be interesting to evaluate the real impact
that the reduction of the corporate income tax rate will have
on investments made by US private equity firms in Mexico since
many large infrastructure projects take advantage of tax
incentives, such as the accelerated depreciation of fixed
assets, which might have more weight in the returns of the
investors. Projects with no tax incentives in Mexico would
definitely have a hard time competing against US projects for
capital.

The corporate income tax rate reduction and the territorial
tax system implementation would imply that the US tax regime
would be considered as a preferential tax regime or 'tax
haven’ (REFIPRE), with all of the underlying tax
implications that this entails.

Although a thorough analysis should be made once the
definitive reform bill is passed, both the Mexican governmental
authorities and the private sector should evaluate how these
reforms could impact Mexican investments and should therefore
assess the implementation of the appropriate measures to
counter any negative outcomes.

Currently, the newly appointed Mexican Minister of Finance
José Antonio González Anaya has taken the
position that it would still be premature for Mexico to react
with a parallel tax reform. However, he has not rejected the
possibility of enacting a tax reform prior to President
Peña Nieto leaving office in order to preserve foreign
investments in Mexico.

This article was written by Oscar López Velarde
Pérez and Juan Jose Paullada Eguirao of Ritch, Mueller,
Heather y Nicolau, S.C. for International Tax Review.